From the July 2008 issue of Investment Advisor • Subscribe!

Fight the Power

When it comes to FINRA, you may be better off battling city hall

More On Legal & Compliance

from The Advisor's Professional Library
  • Do’s and Don’ts of Advisory Contracts In preparation for a compliance exam, securities regulators typically will ask to see copies of an RIAs advisory agreements. An RIA must be able to produce requested contracts and the contracts must comply with applicable SEC or state rules.
  • Suitability and Fiduciary Duty Recommending suitable investments is more than just a regulatory obligation.  Many investors bring cases claiming lack of suitability, so RIAs must continuously put the onus on clients to notify the advisor of changes in their financial situation.  

Ever wonder whether you could take on the Financial Industry Regulatory Authority (FINRA) and actually come out better than if you had settled? The answer, according to a recent study, is yes, a decent percentage of the time, if you are willing to offset a lower penalty with the legal and psychological costs associated with litigation.

Washington, D.C. law firm Sutherland Asbill & Brennan's fourth annual study on litigated disciplinary proceedings brought by FINRA against broker/dealer firms and registered representatives' attempts to peel the layer of fear and concern in fighting FINRA (formerly NASD) charges by revealing the efforts may pay off.

The study itself is authored by the former deputy chief counsel of enforcement for NASD, Brian Rubin, a partner with Sutherland, and co-authored by associate Christian Cannon, and it does, coincidentally or not, affirm the use of expert legal counsel or having the luck to be backed by a firm in increasing the chance for success in FINRA litigation.

Rubin and Cannon analyzed 72 charges that were litigated in 2007, using mostly data sliced and diced from FINRA's Web site.

The analysis revealed that firms are doing better than individuals and those represented by counsel are doing better than those not represented by counsel at challenging FINRA, says Rubin, who was with NASD for seven years and the SEC before that for four years. "It is harder for the staff to make their case against a litigator with lots of resources."

Of the 72 charges that were litigated during 2007, firms and representatives were successful in getting 11% of the charges dismissed by the Hearing Panel. This statistic has remained basically the same over the previous seven years. But chances of succeeding soar when a respondent is backed by professional muscle, the study found.

Get a lawyer

Broker/dealer firms were far more likely to succeed than individuals. Approximately 29% of the charges against firms were dismissed, compared with approximately 5% for individuals. Those represented by counsel succeeded in getting approximately 17% of charges dismissed, while those without counsel succeeded in getting only 3% of the charges dismissed.

Even with lowered fines, litigation will cost you. "It is a matter of what you are valuing," Rubin says. "It obviously costs money if you litigate but you (may be) reducing the charges." Weigh everything, including public image, he says.

There are lots of reasons why you should settle, he says, mentioning the language and the fine can be negotiated and it brings certainty to the matter, whereas if you litigate, the case could go on for a year or longer. Also there are psychological costs involved in waiting for the decision. "You need to ask whether the costs of litigation out weigh the costs of sanctions. Sometimes they do and sometimes they don't," he says.

FINRA staff believes it has sufficient evidence to bring charges but they do have attorneys able to litigate if necessary, but they also need to justify the sanctions they are asking for before a hearing panel, Rubin says. But, "you can argue that the evidence is not strong or you were acting in good faith or the supervisor told you to do it or you didn't know the rule."

The study also questions the "settlement discount," which refers to a phrase often used, the study avers, to convince a respondent to settle. Surprisingly, sanctions imposed by hearing panels are usually not more severe than the terms offered for settlement, according to the analysis.

Sutherland surveyed 20 counsel who litigated against FINRA from December 2006 through December 2007 to determine whether there is truly a settlement discount. Responses were received by six counsel, who defended six respondents against nine charges and revealed 33% that the staff did not seek more severe sanctions at the hearing than it had offered in pre-hearing settlement negotiations one-third of the time.

In about 83% of the cases, the Hearing Panel ordered sanctions that were equal to or less severe than those sought by the staff during settlement negotiations.

"While these figures could be statistical anomalies, they nevertheless serve as evidence that a settlement discount may not exist because the staff's proposed settlement terms may be too harsh," the study states.

If respondents know that the sanctions they risk by litigating are usually not worse than the proposed settlement sanctions, they may choose to litigate even in cases where liability is all but a foregone conclusion. Since FINRA has access to all settlement offers in all cases, it may want to study this issue carefully and determine whether its settlement offers are fair and are inducing appropriate settlements, the study suggests.

Should You take a shot?

The Hearing Panel for litigation ordered higher fines than requested by FINRA staff approximately 33% of the time in 2007, although in 2006, there were no cases where monetary sanctions sought by the staff were increased, the study found.

When respondents did lose on liability, about half the time they convinced the hearing panel to order a lower monetary penalty. That is basically a heads or tails shot, and a little higher than the previous year's chances after a loss on liability.

However, be careful in challenging fraud cases, the study argues. FINRA staff convinced hearing panels that respondents indeed committed a fraud in all nine instances where fraud was alleged last year.

This could be a trend or an anomaly, given that during the previous seven years, respondents were successful in beating fraud charges approximately 25% of the time--indeed fraud charges were more than twice as likely to be dismissed during that time period as other charges, according to the study.


Elizabeth D. Festa is a freelance business writer based in Washington, D.C. She can be reached by e-mail at elizabeth.d.festa@comcast.net.

Reprints Discuss this story
This is where the comments go.